Josh Kopelman

Managing Director of First Round Capital.

espite being coastally challenged (currently living in Philadelphia), Josh has been an active entrepreneur and investor in the Internet industry since its commercialization. In 1992, while he was a student at the Wharton School of the University of Pennsylvania, Josh co-founded Infonautics Corporation – an Internet information company. In 1996, Infonautics went public on the NASDAQ stock exchange.

Monthly Archives for 2010

Unintended Consequences

I am very happy that the Senate approved the JOBS Act yesterday -- I supported it's passage and believe that it will ease the path for companies to go public faster in a way that maintains meaningful investor protection. I am fully aware, however, that like all legislation, we will find both positive and negative "unintended consequences" the emerge from this legislation. I believe (and hope) that those consequences will be better than the existing situation.

We have already witnessed the unintended consequences of Sarbanes Oxley on the startup industry. There has been a lot of discussion about the decrease in overall IPO volume, the increase in the length of time a company waits before going public, and an increase in companies choosing to exit via M&A instead of IPO. According to a Wall Street Journal editorial, SarbOx has "...managed to kill the creation of new public companies in the U.S., cripple the venture capital business, and damage entrepreneurship."

One consequence of SarbOx that I haven't seen widely discussed, however, is the impact that the reduction in IPO's has had on the public market investor. As companies choose to go public later in their lifecycle, they have materially shifted the "value creation" from public shareholders to private shareholders. When Cisco went public in 1990 it was worth $220M -- so the private investors (founders, employees, investors) benefited from the value creation from zero to $220M. Today, however, Cisco has grown to be worth $110B -- an increase of 491 times their IPO price. And public investors were able to benefit from the value creation from $220M to $110B. This is important. The public shareholder (if they were smart enough to buy Cisco during their IPO and hold it) would have had the same opportunity as anyone else (including the company's founder) to receive 99% of the economic benefit of Cisco's growth!

Take a look at 10 well known tech companies in the chart below -- which includes Apple, Amazon, eBay, Google, Microsoft and Yahoo. The founders, employees and venture investors in these 10 companies benefited immensely from the creation of $32B of value at the time the companies went public. However, the public markets (and public shareholders) were able to benefit from the increase in value from $32 billion to $1.3 trillion. The public shareholder was able to participate in the creation of over One Trillion Dollars in market value creation -- and could enjoy the economic benefit of over 97% of the value creation from these companies. And this is from just 10 companies! If I wasn't so lazy, I could have included hundreds of companies in this analysis...but I'll leave that to others.

This is very different situation from today's crop of IPOs. These companies have waited longer -- and are typically more mature at the time of their public offering. And as a result, they are able to go public at much higher market capitalizations -- it is reported that Facebook will go public at a value of $100B. In order for a public shareholder of Facebook to receive 97% of the economic value, Facebook would have to be worth over 3 trillion dollars. But it's not just Facebook. Twitter is reportedly trading at $8B in secondary market -- and LinkedIn and Zynga both went public with market capitalizations of $5+ Billion. Groupon went public at a value of over $12B -- and most of the economic benefit from that value creation went to the company's founders, employees and investors...rather than their public shareholders.

One result of the shift towards later, larger IPOs has been the increase in secondary transactions -- allowing early shareholders to get liquidity before an IPO. Indeed, there were reportedly over $800M of secondary transactions in Groupon -- and billions of dollars worth of shares have traded in Twitter and Facebook.

My point is not to debate whether today's companies are worth the prices they are getting -- I have no issue with a company selling stock to an educated, willing buyer at a high price. Nor do I have any issue with secondary transactions. Rather, I am just trying to point out that one major impact of the delay in IPO timing is that public investors miss the opportunity to benefit from what could potentially be the creatoin of trillions of dollars of market value.

I recognize that for every Yahoo there is a Lycos -- and for every Amazon there is a Pets.com. And that by delaying a company's IPO, you are also protecting public investors from losing money in these failures (and shifting it to private investors, founders and employees). But I'm not sure that was an intended consequence of SarbOx -- as the intent was to prevent investors from fraud, not to prevent them from making bad investment decisions...

One of the intended consequence of the JOBS Act is to make it easier for startup companies to go public. And I hope that one of the unintended consequences of the bill will be to let public market investors benefit from more of the value that these companies create.